Legal Framework for Impact: embedding climate action in financial regulation

The COP26 summit in Glasgow last month has brought the climate crisis sharply into focus. In order to deliver on the Paris Agreement, all factions of industry and society must work together to sufficiently limit global warming to 1.5°C. This year’s COP has seen a marked focus on the financial sector, with stakeholders from both- public and private realms of finance joining the discussion.  

It has become increasingly apparent that the private sector must collectively shift to a more sustainable mode of operating if we are to achieve the goals set out in the Paris Agreement and the Sustainable Development Goals. However, commitments and target setting from the private sector alone is not enough. We also need governments and policymakers to scale up efforts in the fight against global warming across the whole economy.  

For investors, investee companies are beginning to be held to account and this will have an impact on portfolios. The recent Royal Dutch Shell case court ruling in the Netherlands (plaintiffs alleged the oil giant violated its duty of care under Dutch law and human rights obligations due to its contributions to global warming) exemplifies that we are starting to see a shift in which private actors and investee companies are being held accountable for the impact their production and supply chains have on our environment.1 Alliances, such as the U.N.-Convened Net-Zero Asset Owner Alliance, are already putting short term targets on their portfolios, to increase alignment with societal goals and engaging investee companies on Paris Alignment. But more needs to be done across the economy at large, especially to enable finance and investment to be allocated in ways supportive of keeping global temperature rise to 1.5°C. 

It is crucial that assessing and accounting for sustainability impact becomes a core part of all investment activity. ”A Legal Framework for Impact” authored by Freshfields Bruckhaus Deringer and commissioned by the PRI, UNEP FI and The Generation Foundation identifies ways in which investors can seek to pursue such sustainability impact goals when discharging their legal duties. This however needs to distinguish incorporation of ESG issues in investment decisions from intentionally seeking to influence the behaviour of investee companies for a more sustainable outcome.   

The report makes distinctions between investing for sustainability impact which is likely to improve the financial performance of the portfolio and investing for sustainability impact as an end itself which could be pursued alongside financial objectives. The legal analysis amplifies that in cases where sustainability impact goals are likely to have an effect on achieving financial goals, investors may not only be permitted but legally required to take such factors into account. The report outlines barriers currently faced by investors seeking to invest for sustainability impact. These include a lack of legal clarity as well as impediments to navigating the relationship between investment decisions, financial returns and sustainability impact in practice. Policymakers need to step in with necessary policy reforms that address these shortcomings such as clarifying how investors’ core legal duties and discretions relate to sustainability impacts according to the letter of the law and in investment practice.  

While it is evident that global investment practices must rapidly move towards a paradigm that more comprehensively considers sustainability impact, policymakers must ensure that their messaging around obligations and duties, as well as how investment mandates can consider impact, are coherent.  In the plethora of announcements made in Glasgow and globally during November 2021, it is important to ensure that policy frameworks enable and reinforce credible commitments. Trillions of dollars must move if the world is going to meet the climate ambitions set out by policymakers and private sector actors at COP26. There is no time to waste. 

Notable outcomes include pledges to phase-out fossil fuel subsidies and reduce coal as well as commitments to cut methane emissions and end deforestation. The need for public-private alignment becomes prevalent when taking a closer look at some of the commitments made for example, UK’s announcement to become a net-zero financial center by making corporate net zero planning a mandatory requirement. This year’s COP also saw the first international coalition of countries, the Beyond Oil and Gas Alliance (BOGA), coming together and committing to end oil and gas extraction. This commitment should have alignment impact on financial institutions domiciled there, particularly subject to sovereign wealth funds. Last but not least, there is the Glasgow Financial Alliance for Net Zero which brings together over 130 trillion USD of private capital, spanning across the entire financial industry, to support financing the transition to a net zero economy.  

Now, post-COP priorities will lie in ‘walking the talk’ and taking credible action to uphold pledges made by policymakers, investors and businesses alike to limit global warming. To do so, a reform of the baseline of investment regulations is required so that all investors can consider their impact on climate goals and manage that impact accordingly.   

Read more about A Legal Framework for Impact here.  

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